Employees participating in 401(k) plans may not be aware that their retirement investments could be influenced by concealed financial arrangements. Research conducted by Clemens Sialm, a finance professor at the University of Texas at Austin, indicates that many funds included in these plans are selected based on revenue-sharing agreements, potentially leading to higher fees and lower returns for employees.
The study, titled “Mutual Fund Revenue Sharing in 401(k) Plans,” published in Management Science, examined the largest 1,000 401(k) plans reported to the U.S. Department of Labor between 2009 and 2013. Sialm, along with colleagues Veronika Pool from Vanderbilt University and Irina Stefanescu from the Federal Reserve, discovered that over half of these plans—54%—included at least one fund that engaged in revenue sharing with recordkeepers, the companies responsible for administering retirement plans.
Impact of Revenue Sharing on Investment Choices
The findings reveal that funds participating in revenue-sharing arrangements are significantly more likely to be included in 401(k) plans. In fact, revenue-sharing funds were found to be 60% more likely to be added compared to non-revenue-sharing options and were less frequently removed from investment menus.
Despite their inclusion, these funds often do not deliver favorable outcomes for employees. They typically charge higher administrative fees, partly because they rebate an average of 18% of these fees back to recordkeepers. Sialm explains, “Plan sponsors and providers are willing to include these investment options on the plan because they are willing to cover a larger fraction of administrative costs.” Moreover, revenue-sharing funds have been shown to perform worse financially over time when compared to their non-revenue-sharing counterparts.
Strategies for Enhancing Transparency
Given the implications of these findings, Sialm urges employees to seek greater transparency regarding the fees associated with their investment options. A seemingly small difference, such as a 1% increase in fees, could result in tens of thousands of dollars lost in returns over a 30-year period. He advocates for employers to present fee structures in a clear and straightforward manner, as lengthy documents with hidden footnotes provide little assistance to employees trying to understand their costs.
Sialm also suggests that one effective way to reduce the prevalence of revenue sharing is for employers to compensate recordkeepers directly for their administrative services. This approach would eliminate the reliance on hidden fees, creating a more equitable compensation structure. He states, “Administering 401(k) plans is expensive, and recordkeepers need to be compensated for their services. It would be more fair if the sponsor companies would cover their administrative costs.”
As employees navigate their retirement investment options, understanding the potential impact of revenue-sharing arrangements is crucial. By advocating for transparency and straightforward fee disclosures, workers can better protect their financial futures.
For further details, refer to the full study by Sialm and colleagues in Management Science.
